The
following item is a Letter of Intent
of the government of the Federal Republic
of Yugoslavia, which describes the policies
that the Federal Republic of Yugoslavia
intends to implement in the context of
its request for financial support from
the IMF. The document, which is the property
of the Federal Republic of Yugoslavia,
is being made available on the IMF website
by agreement with the member as a service
to users of the IMF
website.

Over
the past several months, we have formulated
and started implementing, in cooperation
with the Fund and the World Bank, a comprehensive
stabilization and reform program for
2001 aimed at setting the basis for sustainable
economic recovery and improvement in
living standards. Our program is described
in detail in the attached Memorandum
on Economic and Financial Policies. In
support of this program, we hereby request
on behalf of the FRY authorities a stand-by
arrangement in the amount of SDR 200 million,
with an expiration date of March 31,
2002.

We
believe that the policies and measures
described in the attached memorandum
are sufficient to achieve its objectives,
but we stand ready to take additional
measures and seek new understandings
with the Fund, if necessary, to keep
the program on track. We will remain
in close consultation with the Fund in
accordance with the Fund's policies on
such consultations, and will provide
the Fund with all information that it
requests to assess the implementation
of the program. The program will be reviewed
by the Fund by August 15, November 15,
2001, and February 15, 2002.
The first review will focus on developments
in the budget and the pension fund, monetary
and exchange rate policy, and bank restructuring,
while the second review will be the occasion
for reaching understandings on fiscal
policy for 2002.

1.
This memorandum sets forth the economic
objectives and policies of the federal
and republican governments of the Federal
Republic of Yugoslavia (FRY) for 2001,
which have been formulated within a medium-term
framework geared to achieving sustainable
growth and external viability. As described
below, the economic program is comprehensive
in scope, encompassing policies to address
severe macroeconomic imbalances, reform
the public finances, and restructure
the banking and enterprise sectors. Annex A
to this memorandum describes the quantitative
performance criteria and indicative limits
under the program; Annex B lists
the prior actions and preconditions for
consideration of the program by the IMF
Executive Board, and the structural performance
criteria and benchmarks under the program;
and Annex C defines the performance criteria
and indicative targets and describes
the reporting arrangements.

2.
The strengthening of democracy in FRY
since last October has set the basis
for FRY's reintegration with the world
economy and the initiation of economic
reform. The events of last October
ushered in important changes in federal
policies and institutions, including
at the National Bank of Yugoslavia (NBY).
On December 20, 2000, FRY became
a member of the Fund and adopted--and
has since firmly implemented--a post-conflict
program supported by the Fund. Following
elections in Serbia on December 23,
2000, a new government was formed in
late January 2001, giving new impetus
to the reform effort. The federal and
both republican governments are fully
committed to the implementation of the
macroeconomic and structural policies
described in this memorandum.

II.
Background

3.
The economic legacy of ten years of regional
conflicts, isolation, and economic mismanagement
is dismal. Output stands at about
50 percent of its 1989 level;
infrastructure is in disrepair; recorded
unemployment is about 30 percent
of the work force; 12-month inflation
runs at about 120 percent; average
wages are at about DM 140 per month;
and the external position is nonviable,
owing in part to a crushing debt burden.
Economic performance in 2000featured a modest output recovery,
with real GDP growing by about 5 percent,
recovering partially from a 16 percent
decline in 1999 as a result of the
Kosovo war. A severe drought resulted
in a 19 percent decline in
agricultural output, while industrial
output rose by 11 percent. Since
last September, industrial output has
trended downwards apparently due to energy
shortages and capacity constraints after
a decade of disinvestment. Meanwhile,
benefits from the lifting of the sanctions
have yet to materialize. Following price
liberalization in October and a price
jump in the late months of 2000,
inflation is now running at an annualized
rate of 46 percent, reflecting in
part continued administered price adjustments.
The economy of Montenegro has also suffered
massively as a result of the economic
disruptions in the region over the past
decade, although the standard of living
has declined less than in Serbia. The
adoption by Montenegro of the DM (euro)
as its sole currency last November has
helped stabilize prices and strengthen
financial discipline, but has also revealed
underlying weaknesses in the economy.

III.
Economic Objectives and Policies for 2001

4.
The envisaged policies of the federal
and republican governments will set the
basis for a viable external position
and sustainable output recovery by: reducing
macroeconomic imbalances, advancing economic
restructuring, and catalyzing external
assistance, including debt relief.
In light of difficult initial conditions,
achieving these aims will require generous
support from creditors and donors, as
well as difficult policy choices at home.

5.
Macroeconomic policies in Serbia will
be geared to lowering inflation while
protecting the most vulnerable groups
of the population and supporting a sustainable
output recovery. In this regard,
credit and fiscal policies will be constrained
by the severe demonetization of the economy
and the prospect of a gradual recovery
of confidence in the dinar. Accordingly,
the target for the general government
deficit in 2001 is consistent with
limited borrowing from the banking system
(0.6 percent of GDP in 2001),
while the monetary program is based on
the assumption of unchanged velocity.
Wage policy in the state sector will
aim to keep the annual wage bill constant
in real terms on the basis of the targeted
rate of inflation, which should help
limit inflation, including through its
demonstration effect.

6.
Structural policies in Serbia will seek
to reduce price distortions and impediments
to growth, although with significant
economic and social costs. The program
for Serbia includes a major liberalization
of the foreign exchange, trade, and price
regimes; a radical reform of the public
finances; restructuring of the banking
system; and important steps in enterprise
restructuring and privatization. Policy
implementation will impose economic dislocation,
which needs to be addressed through targeted
social support. Foreign assistance, some
of which remains to be secured, should
facilitate reform by helping to alleviate
social hardship.

7.
Consistent with the above policies, the
program for Serbia aims at rapid disinflation
and a moderate recovery in output.
Specifically, the program will aim at
lowering 12-month (retail price) inflation
to 30-35 percent by end-2001. This
is consistent with underlying inflation
of 15-20 percent, broadly in line
with recent trends, and large adjustments
in utility prices. Real GDP is expected
to rise by around 5 percent in 2001,
owing mainly to a rebound in agricultural
output after last year's drought. The
rest of the economy will probably grow
by 2-3 percent, with the positive
effects from the removal of the sanctions
being moderated by capacity constraints
and the adverse short-term impact of
economic restructuring.

8.
In Montenegro, macroeconomic policies
reflect the republic's own monetary and
exchange regimes. As the centerpiece
of its economic program, the government
in November 2000 successfully adopted
the DM (euro) as the legal tender
of the Republic, replacing the dual system
that had existed for the previous year.
This radical currency reform, has revealed
underlying weaknesses in the fiscal and
banking spheres, and precluded the possibility
of superficial correction by recourse
to money creation and inflation. For
this reason, the burden of fiscal adjustment
on Montenegro will be particularly difficult.
The advent of price stability has also
introduced more realism to the expectations
of the population, facilitating a government
policy to refrain from any further increases
in the minimum wage during 2001.
Consistent with these policies, 12-month
inflation in Montenegro is expected to
decelerate to about 6½ percent
by end-2001, compared with about 25 percent
at end-2000, while output is expected
to rise by 5 percent in 2001.

9.
In both republics, external consolidation
is a key objective of the program.
The program aims at containing FRY's
current account deficit (after
grants) to US$1.2 billion (11½
percent of GDP) in 2001 and strengthening
gross official reserves by the equivalent
of about US$200 million, roughly
corresponding to purchases from the Fund.
Exports are expected to rise by 7½ percent
in U.S. dollar terms, reflecting
a rebound in the second half of the year
in response to the removal of international
sanctions. Imports are projected to rise
by19 percent in U.S. dollar
terms, largely as a result of increased
foreign assistance. These projections,
as well as assumptions about the capital
account, reserve accumulation, and arrears
clearance, imply a financing gap of about
US$10.7 billion in 2001, of
which about US$0.8 billion could
be covered by balance of payments and
project assistance and the remainder
by rescheduling of arrears and current
maturities and capitalization of moratorium
interest. Financing for a significant
part of the remaining gap is expected
to be identified in the context of the
Donor Conference scheduled for June 29,
2001.

A.
External Outlook and Debt Management

10.
The outlook for FRY's external position
is overshadowed by the crushing burden
of its external debt, the bulk of which
is in arrears. At around 145 percent
of GDP at end-2000, external debt cannot
be serviced without unacceptable sacrifice
of economic activity. Accordingly, the
FRY authorities are requesting from Paris
Club creditors a rescheduling on Naples
terms, including treatment of arrears;
and comparable treatment from other official
bilateral and commercial creditors. However,
even with concessional debt relief and
rescheduling, a substantial financing
gap would persist over the next few years,
owing to the rising debt service burden
and reconstruction needs. Accordingly,
in the context of the June Donor Conference
and in discussions with official donors
and creditors, the FRY authorities will
be seeking support of the order of at
least US$1.2 billion per year (on
a commitment basis) through 2005.

11.
In light of the difficult external debt
position and the prospects for substantial
external support on highly concessional
terms, the federal and republican governments
and the NBY will refrain from borrowing
or guaranteeing foreign loans on nonconcessional
terms. The only exception to this
policy will be loans provided directly
by the EBRD, EIB, IBRD, or IFC.

12.
The FRY authorities will intensify efforts
to reach agreement with the other successor
states on the division of the assets
of the former Yugoslavia. Frozen
gold and foreign exchange deposits of
the NBY with banks abroad amount to about
US$0.9 billion. The division of
these and other disputed assets among
the successors to the former Yugoslavia
is likely to be a complex process.

B.
Fiscal Policy

13.
Fiscal policy in 2001 will be geared
to disinflation, supporting a sustainable
economic recovery, addressing the costs
of the transition, and enhancing transparency
in government operations. Specifically,
the fiscal program for 2001 provides
for: (i) strict limits on general
government borrowing from the banking
system; (ii) increased social transfers
targeted toward the most vulnerable groups
of the population; and (iii) a bold
fiscal reform in Serbia to eliminate
major tax distortions and enhance transparency
in spending. A large portion of investment
and economic restructuring programs in
Serbia has been explicitly identified
as contingent on external financing.
This segment of expenditures will be
presented at the Donor Pledging Conference
in June 2001 as Serbia's supplementary
"budget for recovery and reconstruction,"
with a view to attracting foreign financial
assistance. Excluding Serbia's supplementary
budget, total public expenditure on a
consolidated basis will reach some 43.6 percent
of GDP in FRY, with the federal government,
Serbia and Montenegro accounting for
6.7, 33.1, and 3.8 percentage points,
respectively. On this basis, the overall
cash deficit (before grants and privatization
receipts) of the general government in
FRY is projected to reach 3.8 percent
of GDP in 2001. This will be financed
by recourse to the banking system in
an amount equivalent to 0.6 percent
of GDP, privatization receipts of 1.4 percent
of GDP, and foreign grants and loans
of US$180 million or 1.8 percent
of GDP. Excluding foreign assistance
in support of Serbia's budget for recovery
and reconstruction, an additional US$550 million
(5½ percent of GDP) of humanitarian
and reconstruction foreign assistance
is estimated to be delivered outside
budget channels. The supplementary budget--whose
scope and size will depend on commitments
at the June Donor Conference--is preliminarily
estimated at about 2.3 percent of GDP
in 2001. Such spending is likely to have
limited, if any, inflationary effects--since
it will be fully foreign-financed, have
a large import component, and tend to
involve idle resources in the construction
sector--while it would help remove bottlenecks
in infrastructure and enhance productive
capacity.

14.
Budget execution will be subject to a
high degree of uncertainty owing to major
structural fiscal reforms and bank and
enterprise restructuring. To facilitate
orderly budget execution, the federal
and the republican governments shall
(i) in close collaboration with
Fund staff, monitor revenue performance
to allow for timely corrective actions;
(ii) backload discretionary expenditure
to create additional cushioning; (iii) refrain
from allocating any part of general reserves
to existing budget programs until the
last quarter of the year, and consult
with Fund staff prior to any major allocation
of general reserves; (iv) identify
expenditures of 0.5 percent of GDP in
the Serbian budget that will only be
undertaken after consultation with the
Fund staff and taking into account overall
fiscal trends; and (v) if budget
execution data point to a higher consolidated
general government deficit than envisaged
under the program, immediately impose
fiscal measures to maintain the budget
deficit within the agreed target on a
sustainable basis.

15.
Achieving fiscal sustainability over
the medium term will be a challenging
task. The fiscal position of the
general government in FRY will remain
under heavy pressure over the medium
term, owing in part to the resumption
of external debt servicing, the gradual
repayment of frozen foreign currency
deposits, enterprise and bank restructuring
costs, and open unemployment, putting
pressure on the unemployment fund and
the budget. With a view to alleviating
these pressures, the federal and Serbian
governments have decided to modify the
original schedule of repaying frozen
foreign currency deposits (FFCDs), by
rephasing repayments as needed to ensure
that they will be limited to no more
than 0.9 percent of projected GDP
in 2005 and subsequent years, compared
to over 2 percent of projected GDP
in 2005-11 on average under the original
repayment schedule. In light of uncertainty
about the overall size of the obligation--as
indicated by the limited withdrawals
in 2000 and so far in 2001 under the
repayment scheme--the government will
issue bonds only up to amounts corresponding
to repayments of DM 10,000 per account
during the period through end-2001, and
will discuss the revised repayment schedule
for 2005 and subsequent years in the
context of the second review under the
stand-by arrangement.

Federal
government

16.
The federal government has adopted new
fiscal measures to ensure that the targeted
decline in federal spending--by 0.8 percent
of GDP--is effected in an orderly fashion.
In particular, salaries in the federal
administration and the federal army have
been frozen at their January level, and
wage payments will be limited to the
equivalent of 12 months salary.
Military pension entitlements will be
reviewed with a view to bringing them
more in line with civilian pension entitlements.
Investment expenditure will be reduced
by some YUD 1.4 billion (or 0.2
percent of GDP). Finally, in order to
ensure that spending on material costs
is kept in line with budgetary resources,
military spending will be brought under
civilian control and its transparency
will be enhanced. To this end, accounting
and other financial functions of the
military have been moved from the General
Staff headquarters to the Ministry of
Defense and will, therefore, be subject
to the standard accounting procedures
of the federal government.

Serbian
government

17.
Tax reform in Serbia will eliminate the
most distortionary elements of the tax
system. With regard to consumption
taxes, all surtaxes have been abolished
and a single rate final-stage tax of
17 percent has been introduced with
a narrow set of exemptions. The effective
tax rate has been thereby raised by 1.8 percentage
points. A federal surtax of 3 percent
will be applied to the same taxable base.
Multiple excise taxes have been replaced
with a system of simplified specific
excises, while a variety of taxes on
financial transaction has been replaced
with a single financial transaction tax.
New draft legislation will regulate all
forms of property taxes, which will be
assigned to local governments. Finally,
the existing local taxes on wages paid
by employers have been unified into a
single local tax. The new tax laws and
amendments were approved by parliament,
in conjunction with the 2001 Budget.
As of June 1, 2001, the tax base
for personal income tax and social security
contributions will be broadened to include
all forms of cash benefits paid to employees;
tax and contribution rates will be lowered
by 10 percent compared to revenue
neutral rates.

18.
To improve transparency, all previous
extra-budgetary programs financed by
earmarked special surtaxes have been
integrated into the budget and all earmarking
of revenues in the Serbian budget has
been abolished. While the social
security funds (pension, health care,
and unemployment) remain separate budget
entities with their own revenues from
social security contributions, all surtaxes
previously earmarked to these funds have
been abolished and revenues from these
taxes have been replaced by transfers
from the republican budget. These transfers
will be adequately sized to ensure that
social security funds do not accumulate
new arrears.

19.
The Serbian budget submitted to Parliament
is consistent with an overall deficit
(before privatization receipts and grants)
of YUD 21.8 billion or 3.2 percent
of GDP. This includes a total transfer
of YUD 23.4 billion (3.4 percent
of GDP) to the social security funds.
As a result of the tax reform discussed
above and the tax administration measures
described below, total revenue is expected
to increase by 1.7 percentage points
of GDP. Concerning expenditures, the
total net wage bill is budgeted to remain
unchanged in real terms on the basis
of the targeted rate of inflation, with
teachers benefiting from a real increase
of 14 percent to reduce inequities.
In order to create room for more competitive
salaries in the public sector, employment
in central government in Serbia will
be reduced by 4,000 people or some 6 percent
by the end of the year. Severance payments
to laid off civil servants will amount
to YUD 1.2 billion, or some
0.2 percent of GDP. The budget provides
for substantially increased funds for
social assistance to the most vulnerable
families (2.4 percent of GDP, compared
to 1.4 percent last year). Subsidies
to producers will amount to 2.4 percent
of GDP, up from 2 percent last year,
concomitant with a reduction in quasi-fiscal
deficits. Funds in the amount of 0.3 percent
of GDP have been allocated to provide
training for workers laid-off as a result
of fiscal reforms and to cover the operational
costs of the Bank Rehabilitation Agency
(BRA). The share of the Serbian budget
for interest payments on restructured
foreign debt is estimated to amount to
0.5 percent of GDP, while its share
for the cost of repayment of frozen household
foreign-exchange deposits will be 0.8 percent
of GDP.

20.
The budget execution system will be strengthened.
Serbia's budget execution system
has been highly inefficient, contributing
to a waste of public funds. To address
the most immediate problems, the Serbian
authorities are committed to carry out
a set of short-term measures to improve
cash management and budget reporting
and introduce commitment control. These
measures have been formulated with the
assistance of a recent IMF Fiscal Affairs
Department technical assistance mission.
The Serbian government is committed to
an ambitious medium-term agenda for improving
expenditure management, which will include
the creation of a Treasury Department.
Concerning arrears, the government's
efforts in 2001 will focus on avoiding
the accumulation of new arrears, while
allowing for a modest reduction of accumulated
arrears, mainly in child care benefits
and agricultural pensions.

21.
The envisaged reform of old-age and disability
pension insurance is key to the attainment
of fiscal sustainability over the medium
to long run. Presently, the pay-as-you-go
system is burdened by an unusually high
dependency ratio (in the Serbian fund,
the ratio of contributors to beneficiaries
fell from 2.6 in 1990 to 1.4 in 2000)
and one of the highest replacement rates
in Central and Eastern Europe (83 percent
for old-age pensions in Serbia). A government-appointed
expert group is analyzing the pension
system and is expected to present recommendations
by end-June. The government plans to
restructure the present system by, among
other things, raising the statutory retirement
age, changing the benefit formulas, and
giving more equal treatment to men and
women. More immediately, the government
plans to sever the link between pensions
and wages, and replace it by indexation
to either the cost of living or a combination
of the cost of living and wages. Also,
with a view to more immediate results,
the government plans to raise the indexation
trigger--which is presently a 5 percentage
point cumulative increase in wages--for
the upper one third of the pensioners.
These two latter measures will be introduced
before end-June 2001. The Serbian budget
includes a total transfer of YUD 16.3 billion
(2.4 percent of GDP) to the pension
funds. However, since the amount of this
transfer was determined on the assumption
that the short-term measures mentioned
above would be introduced together with
the approval of the 2001 Budget, the
delayed changes will require an additional
transfer of YUD 1.3 billion
(0.2 percent of GDP) to be charged
against the general reserves of the republican
budget.

22.
A set of structural measures will be
introduced to improve the operation of
the Health Care Fund. In particular,
the government will extend and redesign
the existing system of co-payments to
promote a more rational use of the services
offered by health care providers under
the state-financed health insurance scheme.
The most vulnerable parts of the society
will be exempted from co-payments. The
new system will be in place by end-May 2001
and will generate YUD 0.8-1 billion
(0.1 percent of GDP) additional
revenue for the Health Care Fund on an
annual basis. In accordance with WHO
recommendations, the government will
revise the list of drugs offered to the
insured population in state pharmacies,
to bring expenditure on drugs in line
with the financial resources available
to the health care system. A decree stipulating
the new list of pharmaceuticals will
be issued by end-June 2001. These
measures should ensure that the Health
Care Fund does not require a transfer
from the republican budget in excess
of the budgeted amount of YUD 2 billion
(0.3 percent of GDP) in 2001,
while meeting its current obligations
in full. Regarding medium-term reforms,
the government plans to appoint a special
committee to produce a concept paper
on reform of the health care system in
cooperation with experts from the World
Bank.

23.
The Labor Market Fund will be allocated
increased resources. Reflecting the
fiscal implications of enterprise restructuring,
thisfund will require a total
transfer of YUD 3 billion (0.5 percent
of GDP) from the republican budget, some
YUD 1.5 billion higher than
originally budgeted. The increase in
allocation to the fund will be charged
against the general reserves of the government.
As noted in ¶46 below, new labor
legislation will seek to improve the
effectiveness of the Labor Market Fund.

24.
A preliminary government review of the
social safety net suggests that there
is room for improvement in its administration
and targeting. In both republics,
social protection is dominated by child
protection programs (with budgeted child
allowances in 2001 amounting to 1.7 percent
of GDP), followed by programs of welfare
assistance to families in greatest need
(about 30,000 households in Serbia and
8,000 in Montenegro, with a total budgeted
cost of 0.3 percent of GDP). The
allocation for child allowances in the
Serbian budget in 2001 was increased
by nearly 1 percent of GDP to 1.6
percent of GDP in 2001 to fully fund
statutory entitlements and settle arrears.
Its targeting will be improved through
greater reliance on regional social protection
centers, while regional inequities will
be alleviated through the temporary programs
of social assistance related to economic
reform. In particular, a fund amounting
to 0.4 percent of GDP will be used
to assist vulnerable families' adjustment
to administered price increases and the
tax reform. A social protection strategy
for the medium term will be elaborated
further in close collaboration with the
World Bank, by September 2001.

Montenegrin
government

25.
Partly as a result of a failure to capture
a substantial share of economic activity
in the tax net, and also partly because
of the need to provide social support
to vulnerable sections of the community,
the fiscal situation remains very difficult.
In 2000, the overall fiscal deficit on
a cash basis (wholly financed by foreign
grants) reached approximately DM 136 million
(10.5 percent of Montenegro's GDP),
while arrears rose by some DM 64 million
(4.9 percent of GDP). A series of
minimum wage adjustments during 2000
(by 60 percent to DM 80 per
month) were partly warranted to correct
distortions caused by a period of high
inflation, but they also severely aggravated
the fiscal burden by increasing public
sector pay and benefit levels. This was
also largely responsible for the rise
in planned expenditure on wages and salaries
in the budget sphere and extra-budgetary
funds of almost 50 percent in DM terms
and a projected increase in pensions
of 20 percent in 2001.
In addition, health expenditures are
expected to rise by some 15 percent
during 2001. These increases cannot
be met by an expected 19 percent
(DM 115 million) increase in
current revenue collection relative to 2000,
and the shortfall will be further aggravated
by a possible 35 percent decline
in foreign grants.

26.
Faced with such a difficult situation,
the government intends to cut expenditures
with a view to limiting the fiscal deficit
(before grants) to DM 95 million (6.5
percent of Montenegro's GDP) in 2001,
in line with expected foreign grants.
Enterprise and quasi-government subsidies
will be reduced by 56 percent and
material expenses by 19 percent.
The achievement of such planned reductions
in expenditures should be facilitated
by the adoption of a new Public Procurement
Law in mid-2001. In addition, the government
intends to complete the liberalization
of prices of basic foodstuffs in August
2001, which will generate savings of
DM 24 million (1.7 percent
of Montenegro's GDP) in annual budgetary
subsidies. The impact of this measure
on socially vulnerable households will
be compensated by additional direct payments
costing some DM 7.5 million.
At the same time, an augmentation of
the system of family material support,
which is means-tested, will cost DM 24 million
on an annual basis, but will be partially
offset by a scaling back of the inadequately
targeted system of child benefits, saving
DM 15 million. These expenditure
plans are rather ambitious on the aggregate
and--despite some DM 9.6 million
(0.7 percent of Montenegro's GDP)
that has been set aside in unallocated
expenditures--the fiscal position remains
precarious. In an effort to minimize
deviations from the budgetary plans and
to improve the flexibility of budgetary
policies, the government will de-link
the statutory minimum wage from public
sector pay and social benefit levels
by end-September 2001. Moreover,
should revenue projections (including
grants) not meet expectations, the government
is prepared to take other measures, as
necessary, to balance the budget and
avoid the accumulation of new arrears.

27.
The preparations for introduction of
a Treasury system from mid-2002 are already
well advanced. This system will substantially
improve budgetary control. The government
has adopted an organic budget law, to
be enacted (in amended form) in mid-2001,
which mandates adoption of a standard
budget classification system and a centralized
treasury system operating within the
Ministry of Finance. It also includes
a provision empowering the Minister of
Finance to close the accounts of line
ministries. In addition, a reorganization
of the Ministry of Finance should improve
operational capacity during 2001. The
introduction of a GFS classification
system for the central government budget
will be extended to cover the extra-budgetary
funds during the course of this year,
leading to the development of reliable
consolidated central government accounts
for 2002.

28.
The extra-budgetary funds remain a critical
source of concern and will require radical
overhaul. The government has already
prepared a general review of the pension
system (with the help of USAID experts)
and intend to consider a number of reforms
during the remainder of this year, for
possible introduction during 2002. An
overhaul of the health system will, however,
have to await much-needed technical assistance.

29.
Plans for a systematic overhaul of Montenegro's
tax policy regime have already been set
in place. By mid-year, the government
will approve a Tax Action Plan delineating
adequate measures for the planning and
implementation of a comprehensive tax
code and with a view to improving tax
collection, broadening the effective
tax base, and lowering tax rates. Tax
administration will be bolstered by a
reorganization that could involve the
merger of all tax functions into a unified
revenue authority.

C.
Quasi-Fiscal Deficits and Enterprise
Financial Discipline

30.
Mindful of the enormous costs to the
economy caused by the supply difficulties
of Serbia's electricity utility (EPS),
electricity tariffs were raised by 60 percent
on average on April 15, 2001 and
will be increased further by 40 percent
on June 1 and another 40 percent
on October 1, 2001. The
April and June price adjustments will
bring the price to a level estimated
by World Bank staff as sufficient to
cover most operational costs this year,
thereby substantially limiting the need
for budgetary subsidies, while at least
US$80 million in donor assistance will
be needed to cover capital repair and
maintenance costs. The October price
adjustment will be the next step toward
bringing the electricity price closer
to medium-term economic cost. The government
has agreed with EPS on cost-cutting measures
to ensure rational utilization of the
increased revenue stream.

31.
The Serbian government is adopting measures
to strengthen financial discipline in
the state-owned enterprise sector.
The eight largest state-owned companies
account for 6 percent of registered
employment and provide key inputs to
the rest of the economy. The Serbian
government is presently establishing
the necessary mechanisms to monitor and
control revenue and expenditure developments,
in particular wage costs and bank borrowing
in these companies. Work on preparing
restructuring programs, in cooperation
with the new managements, has commenced
for the largest among them. In the meantime,
to encourage rationalization in employment
and cost control, the wage bills for
2001 of all state-owned companies in
which average wages exceed those for
the economy as a whole by more than 20 percent
have been frozen at their January level,
thereby ensuring that the state-owned
company wage bill will remain roughly
unchanged in real terms in 2001 on the
basis of the targeted rate of inflation.

D.
Monetary and Exchange Rate Policy

32.
The NBY will maintain tight credit conditions
with a view to lowering inflation.
Quarterly credit and money targets for
end-June and for the remainder of 2001
are consistent with projected nominal
GDP growth, unchanged velocity of seasonally
adjusted broad money, and end-2001 NFA
at US$25 million above its end-2000
level. The assumption of unchanged velocity
reflects conservative assumptions regarding
the rebuilding of confidence in the dinar.
In the event of higher-than-projected
NFA, the NBY will seek to ascertain the
reasons behind this development and its
implications for credit policy, in consultation
with Fund staff. If higher-than-projected
NFA reflects temporary and reversible
factors, the NBY will seek to sterilize
the foreign exchange inflows by maintaining
NDA below the program ceiling. If, instead,
it reflects improved confidence in the
currency, this would allow a correspondingly
higher level of reserve money. In any
event, owing to the uncertainties about
the monetary transmission mechanism and
the economic outlook, the NBY intends
to review the credit targets on a quarterly
basis.

33.
Exchange rate policy will be consistent
with safeguarding external competitiveness
and the foreign reserve target. Despite
a substantial real appreciation in recent
months, the exchange rate of the dinar
appears to be adequate, judging from
its historical real levels and the absence
of downward pressures on the NFA of the
NBY. Nevertheless, the NBY will monitor
developments in the foreign exchange
market closely and will allow the exchange
rate to depreciate as needed to ensure
an adequate level of external cost competitiveness
and to achieve the objective for external
reserves. Exchange rate policy will be
the subject of reviews under the program.

34.
Monetary policy will be increasingly
conducted on the basis of market-oriented
policy instruments. The NBY has doubled
the interest rate charged on shortfalls
in required reserves to 4 percent
and, for reasons of transparency, has
started recording such shortfalls as
credits to banks. Moreover, the NBY will
raise the discount rate to a level that
better reflects conditions in the money
market and will conduct auctions of its
securities in quantities sufficient to
absorb the excess liquidity in the market
and accept the resulting interest rates.
Such policies would permit a relaxation
of exchange and trade restrictions without
undue pressure on the exchange rate.

35.
Further progress toward relying on market-based
monetary policy instruments should be
made once the proper institutional framework
is in place. Following the restructuring
of the banking system in the coming months
and in line with recommendations of the
Fund's Monetary and Exchange Affairs
Department, the NBY intends to replace
the current reserve requirement system
with one based on average reserve deposits,
gradually reduce the required reserve
ratio from its current level of 24.5 percent
as monetary conditions permit, widen
reserve requirements coverage to include
foreign exchange deposits, and increasingly
rely on open market operations in dinars
and foreign exchange for the conduct
of monetary policy

E.
Foreign Exchange and Trade Regimes

36.
The NBY will further liberalize the foreign
exchange market, with the aim of accepting
the obligations under Article VIII
of the Fund's Articles of Agreement following
a review of the exchange system by the
Fund's Legal Department. The foreign
exchange regime has undergone major improvements
since last October, as evidenced by the
unification of the exchange rate and
abolition of onerous exchange restrictions
last December (in the form of mandatory
sales of foreign exchange by importers
and exporters), and the adoption of a
managed float at the beginning of this
year. In addition, administrative procedures
regarding payments for imports have been
simplified, and responsibility for verification
of the nature of the relevant transactions
has been shifted to commercial banks.
Moreover, the ceilings for pre-payment
of imports were abolished for raw materials
and equipment imports, while a 30 percent
ceiling has been maintained for specific
categories of consumer goods. While the
aim of this restriction has been to prevent
capital flight, it could act to also
prevent legitimate current transactions,
and the NBY abolished it in April. The
NBY also abolished the exceptional penalty
on commercial banks regarding payments
for imports that do not eventually take
place. In addition, the recently amended
foreign exchange law will be revised
further, with a view to explicitly allowing
foreign exchange transactions to take
place at any exchange rate, i.e.,
even at rates other than those set at
the interbank foreign exchange market
under the supervision of the NBY; in
the meantime, a NBY decision has allowed
the conduct of foreign exchange transactions
at exchange rates that fall within a
5 percent range around the exchange
rate determined at the interbank foreign
exchange market.

37.
The program provides for a major liberalization
of foreign trade and a tariff reform
in Serbia. Some initial steps in
liberalizing trade were taken last December
when the federal parliament adopted a
number of amendments to the Law on Foreign
Trade with a view to reducing barriers
to entry into the trading industry. Nevertheless,
the foreign trade regime continues to
suffer from numerous quantitative restrictions
and pervasive licensing requirements,
while the tariff schedule is characterized
by high rates with substantial variation
and escalation. In cooperation with Fund
and World Bank staff, the federal authorities
adopted, in mid-May 2001, legislation
to: (a) abolish most of the quantitative
restrictions; (b) adopt a new tariff
schedule; and (c) make progress
toward eliminating export quotas. Non-tariff
barriers were removed with the exception
of about 40 (out of 8,500) tariff
lines covering steel products, and measures
to enforce environmental, health and
safety standards, as well as those related
to national security. Quantitative restrictions
limiting the imports of steel products
will be phased out according to a yet-to-be-established
timetable, which will be formulated in
the context of a restructuring of the
steel industry. In any case, these measures
will be removed in the context of FRY's
WTO accession negotiations. The new import
tariff schedule consists of 6 tariff
bands with rates of 1, 5, 10, 15, 20,
and 30 percent; the simple average
import duty was reduced from about 14 percent
to under 10 percent. For the time
being, export quotas remain in force
on some 30 tariff lines, including
wheat, corn, live animals, edible oil
and sugar. However, as the domestic food
supplies increase, the government intends
to remove these export restrictions on
a case-by-case basis.

38.
In Montenegro, the authorities intend
to continue to foster an open international
trading system, building on the significant
liberalization already implemented over
the past two years. This will be
enshrined in a new Foreign Trade and
Customs Law--to be adopted by end-June 2001--that
will also seek to contain traffic in
illegal substances and maintain appropriate
national health and safety standards.

F.
Bank Reform

39.
The NBY is making good progress in diagnosing
the problems of the banking sector in
preparation for intervening the insolvent
banks. Reflecting the dire conditions
of the enterprise sector, inadequate
banking supervision, and poor corporate
governance over many years, the banking
system is largely insolvent and unable
to perform its intermediation function.
Against this background, in late 2000
the new NBY management sought to ascertain
the financial condition of banks by undertaking
a bank survey that covered most banks
in Serbia on a voluntary basis, with
the assistance of a reputable international
accounting firm. Based on this survey,
banks in Serbia were divided into four
categories: (A) healthy; (B) solvent
but undercapitalized; (C) insolvent
with some systemic importance or potential
economic value; and (D) insolvent
of no systemic importance. Category A
banks will be monitored in the future
with normal supervision tools. Category
B banks will be subject to enhanced supervision
and asked to develop specific recapitalization
plans, under which they will be given
a limited amount of time to restore their
capital to satisfactory levels. Since
February, the NBY has been preparing
diagnostic reports, based in part on
on-site examinations, on category C and
D banks (28 banks, including six
major banks, jointly accounting for about
80 percent of the assets of the
banking system). The diagnostic reports
for the six major banks as well as a
considerable number of smaller banks
are expected to be completed by end-April,
and all diagnostic reports for the problem
banks have been completed as of May 20,
2001. As described in the following paragraph,
these diagnostic reports will form the
base for the intervention of all banks
confirmed to be insolvent.

40.
The banking resolution strategy will
seek rehabilitation or liquidation of
banks on an expeditious basis, taking
into account the prospects for privatization
and the resource constraints. Following
the conclusion of the on-site inspections
of the problem banks, the authorities
have prepared a detailed strategy for
intervention of the insolvent banks and
their resolution, in consultation with
the Fund and the World Bank. The strategy
specifies the modalities of the workout
of the assets carved out of banks. The
NBY envisages that the intervention of
at least the largest banks will take
place at or around mid-June 2001.
Banks that are presumed to have some
systemic importance and value (category C,
likely to include at least the six largest
banks) will be placed under the control
of the BRA for rehabilitation or liquidation.
The rest will have their licenses revoked
and be liquidated under court supervision.
Bank rehabilitation will be undertaken
only if it is expected to produce a viable
bank with good prospects for privatization
through a sale to a private strategic
investor at a reasonable price; and can
be implemented with identifiable fiscal
resources. Banks for rehabilitation will
be restructured financially--through
a carving out of bad debt and partial
creditor haircuts--as well as operationally,
with a view to their achieving core profitability
(i.e., after taking into account the
effect of the negative net worth on income)
within a period of 12 months. If
this appears to be unachievable based
on performance during the first six months--owing,
say, to failure to reach agreement on
a haircut that respects the fiscal constraints
and/or unduly slow progress in operational
restructuring--the banks will be closed
and liquidated. During the rehabilitation
period, the banks' activities will be
tightly restricted, with a view to limiting
contingent government liabilities. In
general, the principle of no new net
lending will apply and all non-retail
credit activity will be subject to BRA
approval. The NBY will deal with the
temporary liquidity needs of the problem
banks strictly within the limits of the
monetary program. In the case of liquidation,
creditors' claims will be satisfied in
accordance with existing legislation
on the seniority of claims and the government
will not assume any liabilities (including
through the granting of new guarantees)
in excess of existing guarantees on deposits.
Given the need for the BRA to focus exclusively
on the management and supervision of
bank restructuring, the authorities will
explore the possibility of transferring
operational control of BRA's assets to
the Privatization Ministry or another
specialized government agency.

41.
The costs of bank restructuring will
be significant--albeit difficult to estimate
at this stage--pointing to the need for
external assistance. According to
preliminary estimates, the uncovered
potential losses of the insolvent banks--excluding
liabilities related to the Paris Club,
London Club, and households' frozen foreign
currency deposits--amount to about US$1.1 billion
(11 percent of GDP in 2001).
This amount could be reduced significantly
were bank creditors to share in the losses.
This will depend on whether the BRA will
be able to negotiate partial creditor
haircuts. The Serbian budget for 2001
provides YUD 600 million for
bank restructuring costs incurred by
the BRA. In addition, funds are expected
to be available from multilateral institutions
(including a portion of the World Bank's
US$30 million trust fund to support
TA for bank resolution), the EU, and
bilateral donors.

42.
The NBY has embarked upon an ambitious
program to strengthen bank supervision.
The program includes a review of prudential
regulations, strengthening of off-site
reporting and analysis, introduction
of on-site risk-based supervision, development
of enhanced supervision and enforcement
measures, and strengthening loan classification
and provisioning regulations. Specifically,
a review of prudential regulations, carried
out with technical assistance from the
Bundesbank, will be completed by end-May.
The review has identified the need to
strengthen legislation and regulations
regarding (i) capital adequacy,
(ii) large exposures, (iii) lending
to connected parties, and (iv) risk
management. The new standards will come
into effect from January 1, 2002,
based on legislation presented to Parliament
by end-June, and supported by new regulations,
staff training, dissemination of internal
manuals, and bank awareness measures
to be carried out during the remainder
of 2001. Under the new regulations, banks
will be expected to produce monthly reports
to bank supervisors on the basis of new
reporting requirements. Supervision and
enforcement will also be strengthened
through the publication of an enforcement
manual by end-June 2001, including asset
classification and provisioning guidelines.
Banks will be given a grace period to
improve compliance with the new regulations
before their rigorous application from
January 1, 2002.

43.
In Montenegro, the restructuring of the
banking system will be a major plank
of reform policies for 2001.
The Council of the Central Bank has been
recently appointed, thereby empowering
the bank to implement the Central Bank
Law approved in November 2000 and to
complete the establishment of core central
bank operations and functions. With donor
assistance, good progress has been made
in enhancing the Central Bank's supervisory
capacity. Legislation and accompanying
regulations have been adopted, establishing
rigorous licensing provisions and financial
reporting and performance requirements
for commercial banks, and containing
strong, prompt, corrective action and
bank exit provisions. The Central Bank
has also initiated an independent external
financial audit of the Clearing and Settlements
Bureau (ZOP), and intends to move ahead
with reform of the payments system as
soon as practicable. Meanwhile, Montenegro's
largest domestic bank is suffering from
a severe liquidity shortage. The Council
of the Central Bank has appointed a temporary
administrator to assume responsibility
for running this bank, which is now precluded
from making any new loans. The future
of the bank will be determined after
two months of a possible 12-month term
of the administrator and a thorough analysis
of the financial and operational conditions
of the bank has been carried out. A foreign
strategic partner may be sought for the
bank but, in any event, no public money
will be expended on the bank's rescue
or recapitalization. However, the social
costs from the reform of the payments
system and the restructuring of the banking
system will be significant. Given the
severity of the budget situation, the
authorities intend to request financial
assistance in support of the reform efforts.

G.
Private Sector Development

44.
In Serbia, a new approach to privatization
has been adopted, with support from the
World Bank. In line with the new
approach, at least 70 percent of
enterprise equity will be offered to
strategic investors with a view to establishing
clearly defined ownership and dominant
owners. Employees and management will
not be given preferential treatment in
the sale of these enterprises, and the
entire process will be conducted under
strict rules to ensure transparency.
The first draft of the new privatization
law has already been completed in cooperation
with the World Bank, and the full legal
framework for privatization will be in
place by end-June 2001. Steps to design
the organizational structure and legal
underpinnings of the Privatization Agency
and decisions regarding its staffing
are being taken in parallel, so that
full operation of the Agency can be expected
by mid-July 2001. In the meantime, privatizations
under the 1997 Privatization Law were
stopped shortly after the new Serbian
government assumed power. Those enterprises
that have begun or completed self-privatization
under this law (about one seventh of
medium and large enterprises) will be
allowed to retain the new ownership structure.
However, the authorities plan to use
the unallocated share of ownership presently
held by the government, and encourage
employee-owners to offer a share of the
ownership in their hands, to offer controlling
stakes for sale to strategic investors
in these companies as well. To facilitate
the further transformation of ownership
in previously privatized enterprises,
the new privatization law will remove
restrictions on the trading of employee
shares.

45.
Serbia's new privatization program will
move along two tracks. First, through
the Privatization Agency, the government
will take charge of initiating and executing
the privatization of the eight largest
state-owned companies, mainly utilities,
as well as of some 120-150 socially
owned enterprises of strategic importance.
In the case of the utilities, their sale
will be preceded by the establishment
of adequate regulatory frameworks. Strategically
important socially owned enterprises
will be sold through tenders offering
at least 70 percent of ownership
to strategic investors. Some 15 percent
of capital of the state-owned and strategic
socially owned enterprises will be distributed
free of charge to enterprise employees,
while another 15 percent will be
placed in a privatization register for
eventual distribution free of charge
to citizens at large. The government
is in the process of privatizing three
cement factories under the authority
granted to it by the 1997 law and,
in cooperation with the World Bank, selecting
another 31 strategic enterprises--to
be divided into seven pools--for early
privatization under the new law. The
authorities envisage to have at least
4 (of the seven) contracts with investor
advisors signed by end-October 2001,
and to be in the position to offer at
least one pool of enterprises for sale
by end-December 2001. Second, with regard
to the remaining 4,000 enterprises
(7,000, including subsidiaries) privatization
may be initiated either by the enterprises
themselves or by the Privatization Agency,
which can propose either a tender or
an auction to attract potential strategic
investors. In any case, the preparation
and execution of the privatization of
all enterprises will be closely supervised
by the Privatization Agency and subject
to well-defined tender and auction rules
to ensure full transparency and accountability
in the process. To provide incentives
to workers and managers for rapid privatization
under this scheme, the costless allocation
of ownership shares to employees would
decline steadily from a maximum of 30 percent
to zero after four years from the coming
into effect of the new law. If after
four years there are still enterprises
that have not been sold, their privatization
will be taken over by the Agency.

46.
Envisaged labor market reform should
improve the business environment and
facilitate economic restructuring.
In this regard, draft laws on labor relations
will be submitted to the federal and
Serbian parliaments by end-June. Similarly,
new laws on Employment and the Rights
of the Unemployed will be submitted to
parliament by end-August. The new legislation
will: (a) guarantee core labor standards,
including the freedom of association
and participation in collective bargaining
for employees and employers; (b) streamline
and reduce minimum statutory benefits
for employment termination and unemployment;
(c) liberalize hiring procedures and
allow for flexibility in the modality
of employment (fixed-term contracts,
part-time employment, seasonal, and casual
labor); (d) liberalize wage determination,
except for the minimum wage; and (e) bring
statutory minimum leave and maternity
benefits to levels affordable to the
majority of the economy.

47.
The federal and Serbian authorities are
establishing task forces to review existing
commercial and bankruptcy legislation,
as well as to identify the obstacles
to its effective enforcement. The
legal system currently favors debtors
over creditors regarding rights arising
in foreclosures, bankruptcies and enterprise
liquidations, while the processes themselves
are lengthy and uncertain. The goal is
to identify the institutional changes
necessary to harden the budget-constraint
and increase the security of property.
Pending implementation of these institutional
changes, new regulations to be adopted
by end-June will allow for greater reliance
on out-of-court procedures that will
run in parallel or in lieu of bankruptcy
and liquidation.

48.
In Montenegro, private sector development
will be predicated on an acceleration
of the privatization program and the
creation of a market-friendly climate
for investors. Privatization of the
majority of shares in all enterprises
will be conducted by international tender
to attract strategic investors and improve
corporate governance, while minority
shares will be preserved for a mass voucher
privatization program that is set to
begin this year. Also, during the course
of 2001, the government intends to approve
a new Company Law consistent with international
best practices, as well as a new Bankruptcy
Law to promote the rapid and efficient
transformation of the enterprise sector.
A new Foreign Investment Law aimed at
protecting investments and guaranteeing
the right to profit repatriation was
already approved in 2000.

Ceiling
on net credit of the banking system to
the consolidated general government3,4

3,373

294

5,373

7,373

7,373

Ceiling
on contracting or guaranteeing of new
nonconcessional external debt with original
maturity of more than one year by the
public sector2,5

.
. .

0

0

0

0

Ceiling
on new external debt owed by the consolidated
general government or guaranteed by the
public sector with an original maturity
of up to and including one year2,6

.
. .

0

0

0

0

Ceiling
on new guarantees and the assumption
of enterprise debt to banks by the public
sector7

.
. .

0

0

0

0

Ceiling
on outstanding external debt service
arrears8

.
. .

0

0

0

0

B.
Indicative targets

Ceiling
on net domestic assets of the banking
system9

19,433

15,720

24,604

28,226

31,226

Ceiling
on change in the arrears of the federal
government

.
. .

0

0

0

0

the
consolidated general government
in Serbia

.
. .

0

0

0

0

the
consolidated general government in
Montenegro

.
. .

0

0

0

0

Ceiling
on the wage bill of the 8 largest public
enterprises, cumulative from beginning
of year10

9,992

4,328

8,756

13,207

17,658

1Quantitative
performance criteria and indicative targets
are defined in Annex C.2In millions of U.S. dollars;
definitions have been revised to take
foreign-exchange denominated liabilities
into account.3For program purposes, the
ceilings on net credit of the banking
system to the consolidated general government
will be adjusted downward by the cumulative
increase in the stock of government debt
held by the nonbank public, starting
from January 1, 2001, and upward for
any decrease.4The consolidated general
government comprises the federal, the
Serbian republican and local governments,
the Montenegrin republican government,
the Serbian and Montenegrin social security
funds, and the Serbian special extrabudgetary
programs.5Excluding loans from the
EBRD, EIB, IBRD, or IFC. The public sector
comprises the consolidated general government
and the National Bank of Yugoslavia.6Excluding normal import-related
credits.7Excluded is indebtedness
arising from the fulfillment of existing
guarantees.8Excludes debts subject to
rescheduling/negotiations. The nonaccumulation
of new external arrears is also a continuous
performance criterion.9Foreign currency denominated
loans and deposits at program exchange
rates.10P Elektroprivreda Srbije,
JP Nafna Industrija Srbije, JP PTT Srbije,
JP Jugoslovenski Aerotransport, JP Zelenicko
Transportno Preduzece Srbije, JP Radio
Televizija Srbije, JP Srbija Sume, and
JP Srbija Vode. Wage bill ceilings are
consistent with nominal wages being maintained
throughout the year at their January
2001 level, in accordance with the Decree
on the Level of Wages and Other Earnings
in Public Enterprises, Official Gazette,
19/01.

(Serbia)
Increase in average electricity tariff
(weighted by consumption)by 60 percent
effective April 15, and by 40 percent
on June 1, 2001.

2.

(Serbia)
Parliamentary approval of (a) a budget
for 2001 and (b) tax reform measures
consistent with program objectives.

3.

(Federation)
Freezing of all salaries paid out of
the federal budgetat the January 2001
level through a government decree.

4.

(Federation)
Liberalization of the foreign trade regime,
involving: elimination of all import
licensing requirements, except those
on 40 tariff lines covering steel products
and those necessary to enforce environmental,
health, safety and national security
objectives; elimination of all export
licensing requirements, except those
on some 30 tariff lines, covering inter
alia wheat, corn, live animals, edible
oil, and sugar; and reducing the maximum
tariff rate to 30 percent, while lowering
the simple average tariff to below 10
percent.

5.

(Montenegro)
Appointment of a special administrator
for the largest bank, which is highly
illiquid.

6.

(Federation)
Agreement with World Bank on an arrears
clearance plan.

7.

(Federation)
Agreement with the EU on an arrears clearance
plan(regarding obligations to the EIB).

8.

(Federation)
Financing assurances from the Paris Club.

II.

Structural
Performance Criteria

1.

(Serbia)
Increase in average electricity tariff
(weighted by consumption) by 40 percent.

October
1, 2001

III.

Structural
Benchmarks

A.

Fiscal
Sector

1.

(Serbia)
Redesign of the co-payment system in
the health care sector, with a view to
generating additional revenue of YUD
0.8-1.0 billion on an annual basis.

end-May
2001

2.

(Montenegro)
Adoption of an organic budget system
law tostandardize budget classification
and implementation of a centralized treasury
system.

end-June
2001

3.

(Serbia)
Issuance of decree revising the list
of drugs offered to the general public
population in state pharmacies, to bring
expenditure on drugs in line with financial
resources available to the health care
system.

end-June
2001

4.

(Serbia)
Improvement of cash management and fiscal
reporting by eliminating primary budget
managers' expenditure accounts and own
accounts of direct spending units (637
accounts and their 850 subaccounts) and
by creating ledger accounts within account
630.

(Serbia)
Establishment of a Central Accounting
Division in the Treasury Department of
the Ministry of Finance and Economy.

end-December
2001

7.

(Serbia)
Establishment of a new system of commitment
control basedin the Treasury's Central
Accounting Division.

end-December
2001

8.

(Serbia)
Set up of a Large Taxpayer Office in
Belgrade.

end-December
2001

B.

Financial
Sector

1.

(Federation
and NBY) Adoption of a strategy for bank
restructuring, in consultation with the
Fund and the World Bank.

May
15, 2001

2.

(Federation
and NBY) Intervention of the six largest,
illiquid, banks in Serbia.

end-June
2001

C.

Private
Sector Development

1.

(Serbia)
Parliamentary approval of privatization
legislation in Serbia, designed in cooperation
with the World Bank, to :

end-June
2001

(a)
attract investment capital by offering
at least 70 percent ofenterprise shares
to investors and no privilege to company
management, management, workers, or any
other agents regarding purchase of these
shares;

(c)
facilitate failed enterprise liquidation/work-outs
prior toprivatization, among other things
by authorizing the Privatization Agency
to require an enterprise to enter workout/liquidation;

(d)
establish transparent and efficient privatization
procedures.

Legislation
to include Law on Privatization, Law
on Shares, Law onAgency for Privatization,
Ordinance on Privatization Program, Ordinance
on Public Tender, Ordinance on Auctions,
Ordinance on Business Valuation, and
Ordinance on Appraisers.

2.

(Serbia)
Conclusion of at least six contracts
for the privatization of either large
companies or pools of six companies each
with investment banks hired through competitive
international tenders (out of a total
of four large companies and five pools).

end-October
2001

3.

(Serbia)
Offer of at least one company or pool
of six companies for saleobserving well
defined, internationally accepted tender
rules.

end-December
2001

ANNEX C

Federal
Republic of Yugoslavia:
Technical Memorandum of Understanding

May
25, 2001

I.
Introduction

1.
This memorandum sets out the understandings
between the Yugoslav authorities and
staff of the International Monetary Fund
(IMF) regarding the definitions of quantitative
and structural performance criteria and
benchmarks, as well as indicative targets,
for the
10-month stand-by arrangement (SBA),
as well as the mechanisms to monitor
the program and related reporting requirements.
To monitor the evolution of the economy
during the program period, the Yugoslav
authorities will provide the data listed
in each section below to the European 1
Department of the Fund, in accordance
with the indicated timing. The quantitative
performance criteria and indicative targets
will be monitored on the basis of the
methodological classification of monetary
and financial data that was in place
on December 31, 2000, except as
noted below. For program purposes, the
public sector consists of the consolidated
general government (comprising the federal,
Serbian Republican and local governments,
the Montenegrin Republican government,
the Serbian and Montenegrin social security
funds, and the Serbian special budgetary
programs) and the National Bank of Yugoslavia
(NBY). The authorities will inform the
Fund staff of any new funds or special
extrabudgetary programs that may be created
during the program period to carry out
operations of a fiscal nature as defined
in the IMF's Manual on Government
Financial Statistics, and will ensure
that these will be incorporated within
the definition of consolidated general
government. Quantitative performance
criteria and indicative targets for end-June,
end-September and end-December 2001 are
specified in Annex A of the Memorandum
of Economic and Financial Policies (MEFP).

For purposes of the program, foreign
reserve assets shall be defined as
monetary gold, holdings of SDRs, the
reserve position in the IMF, and NBY
holdings of foreign exchange in convertible
currencies. The assets should be under
the effective control of, and readily
available to, the NBY. Excluded from
foreign reserve assets are frozen assets
of the Federal Republic of Yugoslavia
(FRY), undivided assets of the Socialist
Federal Republic of Yugoslavia (SFRY),
long-term assets, NBY claims on bank
and nonbank residents, as well as Yugoslav
commercial banks located abroad, any
assets in nonconvertible currencies,
encumbered reserve assets pledged as
collateral for foreign loans, reserve
assets pledged through forward contracts,
and precious metals other than gold.
Monetary gold shall be valued at an accounting
price of US$272.60 per ounce, and SDRs
at SDR1 = US$1.3029. On December 31,
2000 the NBY's foreign reserve assets
as defined above amounted to US$516 million,
including gold valued at US$125 million.

For purposes of the program, foreign
reserve liabilities shall be defined
as any short-term loan or deposit (with
a maturity of up to and including one
year), swaps (including any portion of
the NBY gold that is collateralized),
and forward liabilities of the NBY--in
convertible currencies to residents and
nonresidents; IMF purchases; and loans
contracted by the NBY after December 31,
2000 from international capital markets,
foreign banks or other financial institutions,
foreign governments, and bridging loans
from the BIS, irrespective of their maturity.
On December 31, 2000, the NBY's
foreign reserve liabilities, as defined
above, to nonresidents were US$152 million
and to residents were US$672 million.

All assets and liabilities denominated
in convertible currencies other than
the U.S. dollar shall be converted at
their respective exchange rates against
the U.S. dollar prevailing on December 31,
2000. All changes of definition or valuation
of assets or liabilities, as well as
details of operations concerning sales,
purchases or swap operations with respect
to gold shall be communicated to the
Fund staff within one week of the operation.

3.
Reporting. Data on foreign reserve
assets and foreign reserve liabilities
of the NBY shall be transmitted to the
European 1 Department of the Fund
on a weekly basis within four business
days of the end of each business week.
To facilitate program monitoring, the
NBY will provide the data at the indicated
constant prices and exchange rates, as
well as at current exchange rates (Annex A).
The NBY will report if any of the reported
foreign reserve assets are illiquid or
pledged, swapped, or encumbered.

4.
Adjusters. For program purposes
the floor on net foreign assets will
be adjusted upward pari pasu to the extent
that: (i) the NBY recovers frozen
assets of the FRY, undivided assets of
the SFRY, long-term assets, and foreign-exchange-denominated
claims on resident banks and nonbanks,
as well as Yugoslav commercial banks
abroad; (ii) the restructuring of
the banking sector by the Bank Restructuring
Agency (BRA) involves a decline in NBY
foreign-exchange-denominated liabilities
to resident banks; and (iii) cumulative
World Bank disbursements of program loans
during 2001 exceed interest payments
on the World Bank consolidation loan
by more than US$20 million. The floor
will be adjusted downwards to the extent
that cumulative disbursements of EU macro-financial
assistance during 2001 fall short of
debt service and arrears payments to
the EIB, subject to a maximum adjustment
of US$50 million.

B.
Ceiling on Net Domestic Assets of the
NBY

5.
Definition. For purposes of the
program, net domestic assets (NDA) of
the NBY are defined as the difference
between reserve money (as defined in
section E) and net foreign assets
(as defined in section A), with
the latter being converted from U.S.
dollars into dinars at the program accounting
exchange rate of US$1 = YUD 63.1659,
which was the rate prevailing on December 31,
2000 and the exchange rates of the US$
vis-a-vis other currencies prevailing
on that day. As of December 31, 2000,
the domestic assets of the NBY so defined
were valued at YUD 39,315 (Annex A).

6.
Reporting. The ceilings will
be monitored on the basis of daily data
on the accounts of the NBY, reporting
foreign reserves assets and liabilities
as defined under section A and reserve
money as defined under section E
supplied to the European 1 Department
of the Fund by the NBY, within four business
days of the end of each business week.

C.
Ceiling on the Net Credit of the Banking
System to the
Consolidated General Government

7.
Definition. The banking system
comprises the NBY and the commercial
banks, including all banks in Montenegro.
The consolidated general government is
defined above.

For program purposes, net credit of
the banking system to the consolidated
general government is defined as
all claims (i.e., credits, securities,
and other claims in both dinar and foreign
currencies) of the banking system on
the consolidated general government less
all deposits of the consolidated general
government with the banking system, including
foreign currency deposits. Foreign currency
deposits and foreign-currency denominated
credits to the general government will
be reported at the end-December 2000
exchange rates. Any holdings of government
securities by commercial banks mandated
by the NBY against reserve requirements
above the actual amounts held at end-December
2000 (YUD 174 million) will be included
in the credit of the banking system to
the consolidated general government.
Before undertaking any changes to reserve
requirements, the NBY will consult with
the Fund staff. (Net bank credit to the
consolidated general government in Montenegro
will be monitored on the basis of data
supplied by the Montenegrin authorities;
at end-December 2000, net credit of the
banking system in Montenegro to the consolidated
general government in Montenegro amounted
to minus DM 84.8 million.)

8.
Reporting. The ceilings will
be monitored from end-weekly data on
the accounts of the banking system supplied
to the European 1 Department of
the Fund with a lag not to exceed two
weeks.

9.
Adjusters. For program purposes,
the ceilings on net credit of the banking
system to the consolidated general government
will be adjusted downward by the cumulative
increase in the stock of government debt
held by the nonbank public (other than
that related to the frozen foreign currency
deposits), starting from January 1,
2001, and upward for any decrease.

D.
Ceiling on Change in Arrears

10.
For program purposes, indicative targets
will be set on the change in domestic
arrears. Separate indicative targets
will be set for the federal government,
the consolidated general government in
Serbia, and the consolidated general
government in Montenegro.

11.
Definition

For the purpose of establishing compliance
with this indicative target, the federal
government is defined to comprise all
budgetary institutions financed from
the federal budget, including the federal
army and the federal pension fund for
retired military personal. The consolidated
general government in Serbia is defined
to comprise all budgetary institutions
financed from the Serbian republican
budget, the Republican Pension and Invalidity
Insurance Fund for Employees, the Republican
Pension and Invalidity Insurance Fund
for Self-employed, the Republican Pension
and Invalidity Insurance Fund for Agricultural
Workers, the Republican Health Insurance
Fund, the Republican Labor Market Agency,
all republican special directorates,
the Serbian Development Fund, and all
other budgetary and extrabudgetary funds
created by the government of Serbia existing
before or created during the period of
the program. The consolidated general
government in Montenegro is defined to
comprise all budgetary institutions financed
from the republican budget, the Republican
Pension and Invalidity Insurance Fund,
the Republican Health Insurance Fund,
the Republican Labor Market Fund, and
all other budgetary and extrabudgetary
funds created by the government of Montenegro
existing before or created during the
period of the program.

The outstanding stock of domestic arrears
comprises wage and pension arrears; arrears
with respect to accrued tax and social
security contribution obligations, including
personal income tax and social security
contributions of employees withheld at
source; arrears on social entitlement
benefits (apart from pensions) to households;
arrears incurred with respect to the
purchases of goods and services from
suppliers; and arrears related to the
servicing of domestic debt.

The outstanding stock of wage arrears
at a particular date are defined as total
accumulated unpaid wages of all employees
on the regular payroll of all units belonging
to the parts of the general government
as defined above, up to the latest preceding
regular pay date, which have not been
settled by the test date. The total stocks
of wage arrears, thus defined, are on
a gross basis and are calculated by summing
the wage arrears of all units of government
with regard to their own employees; transfers
between different levels of government
for making wage or other payments are
excluded from the estimates of these
wage arrears.

Pension arrears are defined as total
accumulated pensions due but not disbursed
by the pension funds concerned to all
pensioners in the pension rolls up to
the latest preceding pension disbursement
date.

The outstanding stocks of tax and social
contribution arrears at a particular
date comprise total accumulated accrued
tax obligations of the parts of the general
government as defined above that have
not been paid by the test date. The total
stocks of such arrears are on a gross
basis and are calculated as the sum of
such arrears.

Social entitlement payments, apart from
pensions, are defined as all cash payments
due directly to, or on behalf of, the
population in accordance with stipulations
in the law and which are not contingent
upon the provision of any services or
sale of any goods or assets to the general
government by such members of the population
in return for these payments. The stock
of such entitlement arrears are defined
as total accumulated payments due but
not disbursed by all units of government
up to the test date. Thus defined, these
arrears are also on a gross basis and
do not include the netting out of any
transfers made between different units
of the general government for the payment
of such entitlements.

Arrears to suppliers comprise payments
delayed beyond what was explicitly specified
in relevant contracts, or in the absence
of such specification, for two months
from the date of submission of bills,
for already-effected purchases of goods
or services by the government concerned.
These include, inter alia, arrears
to utility companies, arrears incurred
with respect to service and maintenance
contracts, and payments not made for
the purchase of goods and supplies such
as equipment and furniture. These arrears
are also defined on a gross basis and
overdue tax and other obligations to
the government of the relevant enterprises
are not included in the calculation of
the arrears of the government unless
there is mutual agreement on the cancellation
of debts. Netting out of any transfers
made between different units of the general
government for the payment of such arrears
and obligations are also not taken into
consideration.

Arrears to domestic banks and nonbank
lenders comprise all overdue payments
related to financial contracts between
the government and domestic banks, nonbank
financial institutions, nonfinancial
institutions, and private lenders.

At end-December 2000, the stock of arrears
of the Federal government was estimated
at YUD 7.063 billion; and the stock
of arrears of the consolidated general
government in Serbia was estimated at
YUD 32.522 billion.

DM denominated claims on government will
be converted at the exchange rate of
DM 1 = YUD 30; claims
denominated in currencies other than
the DM will first be converted at their
respective exchange rates against the
DM prevailing on December 31, 2000.
The change in arrears is defined as the
change in the end-period stock of arrears.
Changes in wage and pension arrears will
be adjusted for the changes in the average
wage and average pension in the economy
relative to their respective values in
December 2000.

12.
Reporting. Before the last business
day of each month, data on end-period
stocks of arrears for the previous month
will be supplied to the European 1
Department of the Fund by the Federal
Ministry of Finance, the Ministry of
Finance of Serbia, and the Ministry of
Finance of Montenegro.

E.
Definition of Reserve Money

13.
Definition. Reserve money is
defined as the sum of currency in circulation
(NBY Bulletin, September 2000, Table 3A,
column 8) and reserves banks are
required to hold under the standard reserve
requirement, plus excess reserves of
the commercial banks at the NBY. Shortfalls
in reserves that banks are required to
hold, will be included in required reserves
(and therefore in reserve money), as
well as in bank borrowing from the NBY.
Reserves that banks are required to hold
under the standard reserve requirement
are currently set at 24.5 percent
of the base as defined in the NBY Decision
of September 24, 1999. Reserves
that banks hold at the NBY to satisfy
other additional or special reserve requirements
will not be included as part of the amounts
necessary to satisfy the standard reserve
requirement. The amounts that banks are
permitted to hold in securities to satisfy
the statutory reserve requirement will
be limited to the amount that banks were
holding as of December 31, 2000
banks YUD 174.1 million. Excess
reserves include commercial bank balances
in Giro accounts 620 and 625 with the
NBY and cash in commercial bank vaults.

14.
Data on reserve money will be monitored
from the daily indicators data of the
NBY, which shall be supplied to the European 1
Department of the Fund weekly by the
NBY with a three-day lag. On December 31,
2000, currency in circulation amounted
to YUD 10,933 million while required
reserves amounted to YUD 4,824.0
million, and excess reserves to YUD 4,088
million. Data on effective reserve requirements
and the deposit base used in reserve
requirement calculations will be supplied
to the European 1 Department within two
days of the 11th, 18th,
and 28th day of each month.

15.
Adjusters. For program monitoring
purposes, reserve money will be adjusted
as follows: Should the standard reserve
requirement increase (decrease) from
the level prevailing on [December 31,
2000], the ceiling on net domestic assets
would be increased (decreased) by an
amount equivalent to the change in the
standard reserve requirement ratio multiplied
by the programmed deposit base used in
the calculation of required reserves.
Before making any such changes, the NBY
will consult with Fund staff. Required
reserves of banks placed under BRA administration
or liquidation will remain part of reserve
money for program purposes.

F.
Ceiling on External Debt-Service Arrears

16.
Definition. External debt-service
arrears are defined as overdue debt service
arising in respect of obligations incurred
directly or guaranteed by the public
sector, except on debt subject to rescheduling
or restructuring. The program requires
that no new external arrears be accumulated
at any time under the arrangement.

17.
Reporting. The accounting of
nonreschedulable external arrears by
creditor (if any), with detailed explanations,
will be transmitted on a monthly basis,
within two weeks of the end of each month.
This accounting will include, separately,
arrears owed by the Federal, Serbian
and Montenegrin governments, and other
public sector entities; arrears owed
by Yugoslav Airlines; and arrears owed
to Paris Club creditors, non-Paris club
creditors, and other creditors. Data
on other arrears, which are reschedulable,
will be provided separately.

G.
Ceilings on External Debt

18.
Definitions. First, with regard
to the ceiling on contracting or guaranteeing
of new nonconcessional external debt
by the public sector with original maturity
of more than one year: This performance
criterion applies not only to debt as
defined in point No. 9 of the Guidelines
on Performance Criteria with Respect
to Foreign Debt adopted on August 24,
2000 (Decision No. 12274-(00/85),
see attachment to this Annex) but also
to commitments contracted or guaranteed
for which value has not been received.
Excluded from this performance criterion
are loans from, or other indebtedness
to, the EBRD, the EIB, the IBRD, the
IMF, and the IFC. Concessionality will
be based on a currency-specific discount
rate based on the ten-year average of
the OECD's commercial interest reference
rate (CIRR) for loans or leases with
maturities greater than 15 years
and on the six-month average CIRR for
loans and leases maturing in less than
15 years. Under this definition
of concessionality, only debt with a
grant element equivalent to 35 percent
or more will be excluded from the debt
limit. Second, with regard to the ceiling
on new external debt with original maturity
of up to and including one year owed
by the consolidated general government
or guaranteed by the public sector :
The term "debt" has the meaning
set forth in point No. 9 of the Guidelines
on Performance Criteria with Respect
to Foreign Debt adopted on August 24,
2000 (Decision No. 12274-(00/85).
Excluded from this performance criterion
are short-term import credits.

19.
Reporting. A debt -by-debt accounting
of all new concessional and nonconcessional
debt contracted or guaranteed by he public
sector, including the original debt documentation,
as well as all relevant supporting materials,
will be transmitted on a quarterly basis
within four weeks of the end of each
quarter.

III.
Other Reporting Requirement for Program
Monitoring

A.
Macroeconomic Monitoring Committee

20.
A macroeconomic monitoring committee,
composed of senior officials from the
Federal Government, Serbian and Montenegrin
Ministries of Finance, the NBY, and other
relevant agencies, shall be responsible
for monitoring the performance of the
program, informing the Fund regularly
about the progress of the program, and
transmitting the supporting materials
necessary for the evaluation of performance
criteria and benchmarks.

B.
Developments on Structural Performance
Criteria and Benchmarks

21.
The authorities will notify the European 1
Department of the Fund of developments
on structural performance criteria and
benchmarks as soon as they occur.
The authorities will provide the documentation,
according to the dates in Annex B,
elaborating on policy implementation.
The authorities will also notify the
European 1 Department of the Fund of
any economic developments or policy measures
that could have a significant impact
on the implementation of this program.

C.
Data Reporting

Production
and prices

22.
The following information will be transmitted
at the time of their publication:

The retail price index, the industrial
price index, the industrial production
index, wages and employment, and exports
and imports.

23.
Any revision to the national accounts
data will be transmitted within three
weeks of the date of the revision.

Public
finance

24.
Monthly data on public finance will require
a consolidated budget report of the Federal
and Republican governments comprising:

The revenue data by each major item,
including that collected by the federal
and the republican governments;

Details of the recurrent and capital
expenditure of the federal and republican
governments; and

Details of budget financing, domestic,
and external data will be transmitted
within four weeks of the end of each
month.

Monetary
sector data

25.
The following data will be transmitted
on a daily/weekly/biweekly basis within
one/five working days of the end of each
day/week.

Daily movements in gross foreign exchange
reserves of the NBY at current exchange
rates, indicating amounts sold/bought
at the auction, purchases through ZOP,
purchases on the interbank market, inflows
of foreign grants, inflows of foreign
loans, and repayments of frozen currency
deposits.

Treasury bill auction details (rates,
amounts per maturity and number of banks
participating in the auction per maturity);
and

Interbank foreign exchange rates and
volume of transactions.

Public sector borrowing and lending from
commercial banks and the NBY

26.
The balance sheet of the NBY and the
consolidated balance sheets of the commercial
banks, including all banks in Montenegro,
will be transmitted on a monthly basis
within three weeks of the end of each
month. The stocks of government and mandatory
and voluntary NBY securities held by
banks and by non-banks, as available
to the NBY, detailed information on interbank
money market transactions (terms, duration,
and participating institutions), and
interest rate developments will be transmitted
on a monthly basis within two weeks of
the end of each month.

External
data

27.
The following data will be transmitted
as follows:

The interbank market exchange rate, as
the simple average of the daily-weighted
average buying and selling rates, will
be transmitted on a weekly basis within
five business days of the end of the
week;

Balance of payments data on services,
private transfers, and capital account
transactions will be transmitted on a
quarterly basis within four weeks of
the end of each quarter; and

Detailed monthly data on the volume and
prices exports and imports, including
a separate report on imported petroleum
products.

(a)
For the purpose of this guideline, the
term "debt" will be understood
to mean a current, i.e., not contingent,
liability, created under a contractual
arrangement through the provision of
value in the form of assets (including
currency) or services, and which requires
the obligor to make one or more payments
in the form of assets (including currency)
or services, at some future point(s)
in time; these payments will discharge
the principal and/or interest liabilities
incurred under the contract. Debts can
take a number of forms, the primary ones
being as follows:

(i)
loans, i.e., advances of money to the
obligor by the lender made on the basis
of an undertaking that the obligor will
repay the funds in the future (including
deposits, bonds, debentures, commercial
loans and buyers' credits) and temporary
exchanges of assets that are equivalent
to fully collateralized loans under which
the obligor is required to repay the
funds, and usually pay interest, by repurchasing
the collateral from the buyer in the
future (such as repurchase agreements
and official swap arrangements);

(ii)
suppliers' credits, i.e., contracts where
the supplier permits the obligor to defer
payments until some time after the date
on which the goods are delivered or services
are provided; and

(iii)
leases, i.e., arrangements under which
property is provided which the lessee
has the right to use for one or more
specified period(s) of time that are
usually shorter than the total expected
service life of the property, while the
lessor retains the title to the property.
For the purpose of the guideline, the
debt is the present value (at the inception
of the lease) of all lease payments expected
to be made during the period of the agreement
excluding those payments that cover the
operation, repair or maintenance of the
property.

(b)
Under the definition of debt set out
in point 9(a) above, arrears, penalties,
and judicially awarded damages arising
from the failure to make payment under
a contractual obligation that constitutes
debt are debt. However, arrears arising
from the failure to make payment at the
time of delivery of assets or services
are not debt.